One of the major recommendations made by the 1997 Wallis Inquiry into banking was to establish a prudential regulator for the financial sector separate from the Reserve Bank of Australia. The new regulator, APRA, became the prudential regulator for banks, superannuation funds and insurers.

APRA’s subsequent track record has been mixed. There have been two major regulatory failures, the collapses of HIH and Bankwest. On the other hand APRA is usually given an important part of the credit for the robustness of the Australian financial system during the financial crisis.

While there would be no argument today over a role for prudential regulation, the case for having a separate prudential regulator is less clear. It is hard to know whether the outcomes during the crisis would have been different if APRA had been established within the RBA rather than outside.

Some of the disadvantages of having a separate, specialist regulator are clear.

To start with, APRA’s terms of reference are much narrower than the Reserve Bank’s.

APRA’s function is to promote financial system stability in Australia, balancing “the objectives of financial safety and efficiency, competition, contestability and competitive neutrality”.

The expectations for the Reserve Bank go further:

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

a. the stability of the currency of Australia;

b. the maintenance of full employment in Australia; and

c. the economic prosperity and welfare of the people of Australia.

As I elaborate in my submission to the Murray inquiry, APRA takes many decisions which it feels are justified on prudential grounds, but which have significant impacts on competition, efficiency, transparency, distribution and economic growth. These arise quite directly from its narrow terms of reference. It seems likely that it would make different decisions if it had a broader set of objectives.

And obviously having two regulators rather than one adds to the direct costs of their operations, and increases the compliance cost for institutions having to liaise with two separate institutions. There are probably economies of scale in regulation.

What are the benefits of having a separate prudential regulator? The most obvious is that we get more focus on prudence than we might in a generalist regulator. Quite possibly we get better quality decisions as a result, but it is very hard to tell. The UK has actually moved prudential regulation back into its central bank because of the poor quality of the decision making in its specialist prudential regulator. Separation does not appear to guarantee quality.

As we look to the future it’s not clear that having an institutional regulator like APRA is the most appropriate. Technology seems to be working to divert an important set of transactions away from (prudentially regulated) institutions, and activity has long been expected to migrate from banks and similar institutions towards financial markets. An institutionally-focused regulator might be fighting the last war.

For me the strongest argument for maintaining a separate prudential regulator has to do with the potential for appeals against its decisions. Many regulated firms have the scope to appeal the decisions taken by their regulators. While it does not seem desirable that the Reserve Bank’s interest rate decisions should be appealed, there is clearly scope to have appeals against decisions taken by APRA.